Mining and Power

DRIVER TOMMY SIMM AT THE CONTROLS OF THE HEADING MACHINE USED TO OPEN UP AROUND 18 MILLION TONNES OF BEESTON SEAM RESERVES AT KELLINGLEY COLLIERY.

COAL MARKET

The coal market has continued to perform strongly during 2008, notwithstanding recent market corrections, with a further sharp increase in the world coal price, following its almost doubling in 2007. As with all commodities, the price of coal is a balance between increasing world demand (2007 up around 3% compared to 2006) against both the supply of mineable reserves and, perhaps more pertinently, logistical difficulties and the costs of getting coal into the appropriate market. Overall, we believe the pricing environment looking forward will remain strong, and that it is unlikely that there will be a major downward shift in the near term in the price of energy generally and of coal in particular.

COAL SALES

Demand for our core product remains strong, not least because, given the high price of gas, coal burn for electricity generators in the UK market remains more profitable than gas, leaving aside the security of supply issues which were reflected in the difficulties encountered over the last winter in the UK obtaining imported gas supplies.

Although a significant portion of our coal production is still contracted, generally under old fixed price contracts, a small portion of our production for the first half has been available for sale at market prices, at times realising in excess of £4.00/GJ. As a consequence, the realised price for all sales in the first half was £1.79/GJ, up 10.5% over the price realised for the whole of 2007 of £1.62/GJ, and up 17.8% over the price for the first half of 2007 of £1.52/GJ.

At 30 June 2008, we had 21 million tonnes of coal contracted to be sold, with 4.5 million – 5 million tonnes due for delivery in the remainder of 2008, 6 million – 7 million tonnes in 2009 and the balance in subsequent years.

Of our total commitments, 10.5 million tonnes is under older “legacy” contracts at an average (fixed or capped) price of circa £1.55/GJ. The balance of the 21 million tonnes contains fixed, capped and floating rate commitments.

There will be a significant reduction over the next 18 months in the amount of this “legacy” contracted coal, with some 7 million tonnes due for delivery by the end of 2009. Providing the coal price remains strong, this will have a marked effect on the profitability and cash flows of the business. It is noteworthy that this reduction in legacy contracted coal will also coincide with an improvement in the expected production at Kellingley and Thoresby as we start to mine their new reserves in the Beeston and Deep Soft seams respectively, although the closure of Welbeck will also take place over this period.

In the short term, we have indicated our expectation for the second half of 2008 of an overall realised sales price of between £1.95 to £2.00/GJ, based upon a market price for the half of approximately $175/tonne (circa £3.50/GJ at an illustrative $2:£1) and production of approximately 5 million tonnes. This would give an overall realised sales price for the full year of £1.90 to £1.95/GJ. Given the contractual commitments for 2009, and assuming no significant change in market conditions, we would expect this to rise to over £2.10/GJ for that year.

The seasonality of sales volumes is not particularly marked, with sales being driven by the timing of production faces rather than customer demand. In contractual terms, the delivery under older contracts tends to be more focussed in the earlier part of the year, although other deliveries and spot sales may obviate this in any given period.

DEEP MINES

Colliery performance summary

	Production (m tonnes) H1 2008	Production (m tonnes) H1 2007	Operating cost* (£m) H1 2008	Operating cost* (£m) H1 2007
Ongoing deep mines
Daw Mill	1.6	1.2	42.4	33.0
Kellingley	0.5	0.8	35.1	35.0
Thoresby	0.3	0.6	32.9	28.8
Welbeck	0.4	0.6	25.9	22.1
Total ongoing deep mines	2.8	3.2	136.3	118.9
Closed/sold deep mines	—	0.1	—	8.3
Total deep mines	2.8	3.3	136.3	127.2

* Operating cost before non-trading exceptional items and depreciation costs, with central costs absorbed.

Overall the deep mines generally met our expectations in the period, with the exception of Kellingley where unexpectedly difficult geological conditions were encountered in the development of the final 900 metres of one of the two gates for the new panel. As a consequence, the roof had to be supported with steel arches for over 500 metres, instead of using the more conventional and significantly faster roof bolting technique and this has resulted in a face gap which lasted until 16 August 2008. This was disappointing, especially given that production rates on the old face had actually been in advance of our expectations.

Daw Mill is now set well, exploiting the current panel, which contained over 6 million tonnes at the start of 2008, and will continue through until the end of 2009. Thoresby which, along with Kellingley, is working its way through some very difficult coal until it can reach its new reserves, had a good first half given the resources available to be mined.

The developments to extend the lives of Kellingley and Thoresby are both progressing well and are on target for production from the new reserves in line with our expectations of mid and late 2009 respectively.

Welbeck had a slightly disappointing first half of the year with production of 0.4 million tonnes, below the first half of 2007 (0.6 million tonnes). This is a result of a delay in the start date for the new face in the aftermath of the previously reported fatality at the mine last year.

At Harworth, we have begun seismic studies to assess the quality and extent of the reserves in the Top Hard seam that we are considering accessing. Bore holes will be sunk in the second half of the year, once planning consent is obtained for the drilling operations. It is intended that these feasibility studies will be completed in order to make a decision in early 2009 as to whether to re-open Harworth.

As expected, overall operating costs in the business have risen reflecting the impact of above RPI inflation increases being felt especially in steel and other material prices, with increased working hours, especially at Daw Mill, also contributing to the rise.

SURFACE MINES

PRODUCTION FROM SURFACE MINE SITES LIKE THIS, LONG MOOR IN LEICESTERSHIRE, IS UP 28.5% ON THE CORRESPONDING PERIOD LAST YEAR.

	H1 2008	H1 2007
Production (m tonnes)	0.9	0.7
Cost before depreciation (£m)	31.6	15.5
Cost per gigajoule before depreciation (£/GJ)	1.52	1.07
Additional provision re fuel increases (£m)	5.6	—
Total cost before depreciation (£m)	37.2	15.5

Surface mines had a good first half, meeting expectations with production up 28.5% at 0.9 million tonnes (H1 2007: 0.7 million tonnes). Production has progressed well at sites successfully opened in the second half of 2007 at Steadsburn, Long Moor and Sharlston.

Planning delays continue to frustrate the development of the business although this has not impacted on production this year. In particular delays on the new Park Wall site have resulted in the deferral of that scheme which was previously expected to start in 2008, although the production shortfall in 2008 will be made up from other sites.

Operating costs, before depreciation (but after amortisation of restoration provisions), in the first half at £1.52/GJ were at the top end of our expectations, reflecting most notably an increase in the cost of “red diesel” from 47 pence per litre at the start of the period to 66 pence at the end of June 2008, although this has subsequently fallen back to circa 60 pence.

As we believe that we have seen a more permanent shift in the cost of energy, notwithstanding some recent market corrections, we have reviewed upwards the provisions required to restore the mine sites at the end of their operating lives to reflect the diesel cost component of these provisions, resulting in an exceptional charge to the income statement of £5.6 million in the period.

HARWORTH POWER

We generated 84,193 MWh (H1 2007: 80,356 MWh) of electricity from mines methane pumped from both operational and closed deep mines. This is enough to power around 37,000 homes, and equivalent to about 60% of the deep mines’ electricity requirements in the period. Our generating station at the former Stillingfleet deep mine, which was commissioned in 2007, has consistently generated at over 90% utilisation, although output at the operating mines was more variable as the methane released from mining operations varies with activity levels.

We are continuing with the lengthy process of gaining planning permissions for wind farms to be built on a number of our sites. Currently we have consent for a 9 MW wind farm at Lynemouth, Northumberland, and are seeking to fulfil planning conditions on this. We have applications for a further 16 MW in the planning system, and we are undertaking planning applications and studies at a number of other sites.